Why in the world can't they fix this thing?
If you're an American monitoring the headlines and gazing east, you're probably wondering why the European debt crisis seems endless, especially after repeated bailouts, central-bank maneuvers and political changeovers meant to replace those who created the problem with more competent leaders.
The problem, for better or worse, is democracy.
If Europe were ruled by rational and omnipotent monarchs, fixing the debt crisis would be fairly straightforward. There would be painful reforms in the bloated, nepotistic labor markets of southern Europe, enforceable targets for reducing debt levels across the euro zone, and a widespread understanding that everybody in Europe, rich and poor, should bear some short-term pain. With that in place, there would also be a plan for making sure the economy grows in a way that benefits as many people as possible.
But electoral politics stands in the way of measures meant to make Europe's troubled nations more competitive and less dependent on borrowed money or bailouts. In the face of intense political pressure at home, for example, the leaders of Spain and Italy are now backsliding on austerity measures meant to cut spending and reduce subsidies that generations of workers have depended on. So the payback is now coming from global investors, who are losing confidence in those economies, pushing up the rates they must pay to borrow, and fueling renewed fears of a European meltdown.
"Austerity fatigue" is beginning to afflict Europe's more prosperous nations as well. French voters seem poised to boot President Nicholas Sarkozy in favor of a socialist candidate who favors more government spending, not less, and might upend the entire fragile agreement with Germany to backstop bailouts for poorer southern neighbors. Even in the Netherlands, voters have sacked a government they felt was too focused on cutting spending. Everywhere in Europe, it seems, voters are losing patience with the gradual tightening of screws that the leaders of France and Germany have favored as the preferred way for Europe to work off excessive debt.
The European Central Bank could still intervene by buying the debt of troubled nations, providing more capital to weak banks or implementing Federal Reserve-style monetary easing. And the International Monetary Fund has been building a just-in-case bailout fund. But absent tough reforms in troubled nations, those two lenders of last resort are reluctant to be the sugar daddy for Europe's extravagant spenders. Sustained cutbacks first. Bailouts second.
That standoff, in turn, delays the inflection point at which Europe's economy, now believed to be in a recession, will stop shrinking and start growing. Just about everybody agrees that it's critical to stimulate growth, since that's the one thing that will indisputably ease the whole problem. "Without spending and growth, there can be no solution to Europe's problems," write economist Barry Eichengreen on the Project Syndicate Web site. But whether to start with austerity measures or more lenient policies is a question that divides economists and policymakers the way team loyalties divide soccer fanatics.
So what's going to happen?
One thing that seems certain is that Europe will remain volatile, with several nations teetering on the brink of disaster and policymakers doing just enough, usually at the last minute, to forestall the ultimate reckoning—a breakup of the euro zone. That's basically what's been happening for the last three years, and could happen for another three. If so, ongoing gradualism "will leave the euro zone vulnerable to further shocks," writes Enam Ahmed of Moody's Analytics. "Regular bouts of anxiety will inevitably weigh on the euro zone's growth prospects." Investors, in other words, should keep the Maalox handy.
Some skeptics feel that sharp spending cuts and other austerity measures are deepening the European downturn and making it more likely that economies like Greece's will shrink so much that leaving the euro zone becomes irresistible. Going it alone would probably be chaotic and risky, but it would allow such nations a chance to devalue their own currencies--boosting exports--and to rely on inflation to shrink debt and artificially pump up paychecks, keeping voter revolt in check.
But austerity might work. David Zervos of investing firm Jefferies argues that rolling back fixed wages, subsidized jobs and other sinecures in southern Europe will make those economies more vibrant, if they're able to stick with it. "This European austerity is a move to free market capitalism," he wrote to clients recently. The United States went through something similar in the 1980s, he says, after Ronald Reagan fired striking air-traffic controllers and ushered in a new era of "laissez-faire labor," which coincided with a 25-year economic boom.
The dysfunctions of the democratic process may even turn out to be the best of a bad set of options. Jacob Funk Kirkegaard of the Peterson Institute for International Economics points out that Europe is in the midst of profound changes that will require indebted nations to give up an unprecedented degree of sovereignty, and richer nations to make their own sacrifices to keep the euro zone intact. It's unrealistic to expect quick solutions to such a complicated problem, he argues, and besides, "threatened with disaster, the political will has emerged to sustain the euro." A few more near-disasters may be just what Europe needs.
Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success, to be published in May. Follow him on Twitter: @rickjnewman.